Happy Thursday, Traderade family! What a day we had yesterday. If you haven't already listened, Ayesha and I hosted a Spaces that covered what happened and why it matters.
Horse and I also discussed during the Midweek Update how the market appears to be poorly hedged and could be headed for more downside.
With everyone focused on the Fed, there's been a lot of other data to observe which I wanted to discuss.
High yield debt is showing a lack of concern regarding the potential for defaults, which is dangerous. It shows complacency and that lack of appreciation for risk is at levels we haven't seen since the Great Financial Crisis started.
Last Friday we saw a record $980 million pile into the high yield debt JNK ETF, almost as if market participants were playing a game of chicken with the Fed. While some of that recent strength has been reversed by selling, what we aren't seeing high yield begin to meaningfully underperform corporate debt.
I believe before this bear market environment is over yield spreads will rise to over 10% (or 1000 bps), which would be more in line with what we see during difficult market and economic conditions. Currently at 4.61%, spreads are pricing in optimism in high yield debt that doesn't reconcile with the increasing potential for an unforgiving recessionary environment.
JOLTS data showed us 700k more jobs than what analysts were expecting, demonstrating resilience that was likely unnerving to a Fed hoping to see the labor market soften.
Chair Powell even made mention regarding the strength of the labor market, as well as the consumer, as areas that gave them cause to continue tightening. The goal being to reduce demand by slowing the economy, in hopes of reducing the velocity of inflation.
The Fed also wants to see wage growth slow, which it has in Q3, but only slightly. Not nearly what the Fed would prefer to see given that there is a relationship between rising wages and rising consumption trends.
One bright spot in the labor market is we are seeing labor force participation recover among older adults. Some of whom sadly likely tried to retire, and with the multi-asset bear market that likely became an impossibility.
A rising labor force participation rate is helpful as it allows more of the open jobs to be absorbed, but the Fed also wants to see less jobs being created, and less people employed as they are aggressively working to mitigate demand-driven inflationary pressures.
Down over 90% from its peak post-COVID crash, the personal savings rate of Americans has plummeted toward lows not seen since 2008 as credit card borrowing has also surged. Many are struggling to balance rising costs with their existing financial obligations. Almost two-thirds of American workers are living paycheck-to-paycheck according to a survey by LendingClub.
Both new and existing home sales are falling as mortgage rates soar to 7%, the highest level since April of 2002. Homebuyer sentiment is near all-time lows as many are priced out by costly homes and increasingly expensive mortgages.
While many secured mortgages at much lower rates, we also saw a flood of buyers acquiring additional properties to rent, use as vacation homes, or attempt to flip for additional money. Many of these same are likely concerned about the real estate situation and some may become motivated sellers, adding to a supply and pressure against prices.
We're also seeing signs that construction is vulnerable. Non-residential construction has been falling since the COVID crash, in part because of the work from home trend adding to a situation where there was already an abundance of commercial office space. But residential construction often catches down when the market dries up, as it has of late.
Overall, US construction posted the biggest drop in 1.5 years during August, showing that the entire industry is beginning to show signs of trouble. Because homebuilders are negatively correlated with rates, and we continue to see rates rise, it is likely that there is further downside for the sector, both in terms of activity as well as equity pricing.
After spending much of last summer concerning ourselves with Evergrand and how it may be the first domino to fall, we see that over a year later China's real estate woes have yet to be resolved.
The Chinese government has poured sizable stimulus into their real estate market, but to little avail. Buyers remain cautious, and many are economically challenged due to the seemingly never ending COVID lockdowns. Because China's real estate market is the biggest market in the world of any kind, it is important to watch for further signs of trouble.
Speculators are reducing margin exposure as rates rise. This is a welcome sign as we see that margin debt as a percentage of the Wilshire 5000 has dropped back toward the COVID lows.
But is this reduction in margin exposure enough? Signs point to no. During prior bear market bottoms the deleveraging process was usually deeper and lasted longer, often seeing margin debt decreased by around 40-50% vs a meager 24% that we see as of September's measure.
Finally, a friendly reminder that central banks play an enormous role in price discovery, both up as they expand their balance sheets, and down as they shrink the same.
Because global central banks are tightening and reducing their balance sheets, the path of least resistance for risk assets like stocks is still lower unless and until that changes in my opinion.